Welcome to the wonderful world of listed companies!

Theoretically, the principles of financial management that we have developed throughout this book find their full expression in the share price of the company. They apply to unlisted companies as well, but for a listed company, market approval or disapproval, expressed through the share price, is immediate. Being listed enables companies to access capital markets and have a direct understanding of the market value of their companies.

When you see that several billion euros can change hands on financial markets in the course of a few hours (when the financial markets are not in crisis!), you understand that markets constitute a very efficient way of exchanging shares compared to the complex negotiations necessary to obtain private financing.

“Paper”, i.e. financial securities, can be placed on financial markets so quickly because:

• financial analysts periodically publish studies reviewing company fundamentals, reinforcing the market’s efficiency;
• listing on an organised market enables financial managers to “sell” the company in the form of securities that are bought and sold solely as a function of profitability and risk. Poor management is punished by poor share price performance or worse – from management’s point of view – by a takeover offer;
• listed companies must publish up-to-date financial information and file an annual report (or equivalent) with the market authority.

Section 42.1 To be or not to be listed?

Whether or not to float a company on the stock exchange is a question that concerns, first and foremost, the shareholders rather than the company. But technically, it is the company that requests a listing on the stock exchange.

When a company is listed, its shareholders’ investments become more liquid, but the difference for shareholders between a listed company and a non-listed company is not always that significant. Companies listed on the market gain liquidity at the time of the listing, since a significant part of the equity is floated. But thereafter, for small or medium-sized companies, only a few dozen or hundred shares are usually traded every day, unless the market “falls in love” with the company and a long-term relationship begins.

In addition to real or potential liquidity, a stock market listing gives the minority shareholder a level of protection that no shareholders’ agreement can provide. The company must publish certain information; the market also expects a consistent dividend policy. If the majority shareholders sell their stake, the rights of minority shareholders are protected (see Chapter 44).

Conversely, a listing complicates life for the majority shareholder. It is true that liquidity gives him the opportunity to sell some of his shares in the market without losing control of the company. Listing can also allow the majority shareholder to get rid of a bothersome or restless minority shareholder by providing a forum for the minority shareholders to sell their shares in an orderly manner. But in return, a majority shareholder will no longer be able to ignore financial parameters such as P/E multiples, EPS, dividends per share, etc. (see Chapter 22) when determining strategy.

Once a majority shareholder has taken the company public, investors will judge the company on its ability to create value and communicate financial information properly. Delisting a company to take it private again is a long drawn-out process. So, for management, being listed results in a lot more restrictions in terms of transparency and communication.

For the company, a stock market listing presents several advantages:

• the company becomes widely known to other stakeholders (customers, suppliers, etc.). If the company communicates well, the listing constitutes a superb form of “free” advertising, on an international scale;
• the company can tap the financial markets for additional funding and acquire other companies, using its shares as currency. This constitutes invaluable flexibility for the company;
• in a group, a parent company can obtain a market value for a subsidiary by listing it (we will then speak of a carve-out) in the hope that the value will be high enough to have a positive impact on the value of the parent company’s shares;
• the company finds it easier to involve employees in the success of the company, incentivising them through stock options, stock-based bonuses, etc.

Now for the warning flags: a stock market listing does not guarantee happy shareholders. If only a small percentage of the shares are traded, or if total market capitalisation is low, i.e. less than €500m, large institutional investors will not be interested, especially if the company is not included in a benchmark index. Volatility on the shares will be relatively high because the presence of just a few buyers (or sellers) will easily drive up (down) the share price significantly. In countries like France and the UK, the authorities have created tax or regulatory incentives (for insurance companies) to encourage investment in such small and mid-cap companies.

Section 42.2 Preparation of an IPO

It usually takes at least six months between the time the shareholders decide to list a company and the first trading in its shares.

This six-month period provides an opportunity for management to revisit some financial decisions made in the past that were appropriate for an unlisted, family-owned company or for a wholly owned subsidiary of a group, but which would not be suitable for a listed company with minority shareholders, such as:

• preparing accounts in line with accounting standards required for listed companies which may be different from the ones used by private companies, and introduce reporting procedures that cover the whole of the entity to be listed;
• reviewing the group’s legal structure in order to ensure that vital assets (brands, patents, customer portfolios, etc.) are fully owned by the group and that the group’s legal form and articles of association are compatible with listing (no simplified joint-stock companies and no pre-emptive rights or special agreements in the articles);
• reviewing the group’s operating structure, ensuring that it is an independent group with its own means of functioning and that it does not retain the structure of a division of a group or a family-run business (terminate employment contracts with non-­operational family members, take out necessary insurance policies, draw up management agreements, etc.);
• drawing up a shareholders’ agreement if there is no such existing agreement (see Chapter 41);
• introducing corporate governance appropriate for a listed company (independent directors, control procedures, board of director committees, etc. – see Chapter 43);
• reviewing the company’s financial structure in order to ensure that it is similar to that of other listed companies in the same sector. This applies particularly to companies under LBO, which will have to partially deleverage via a share issue, at the latest at the time of listing;
• adopting a well-thought-out dividend policy that is sustainable over the long term and that will not compromise the group’s development (see Chapter 36);
• introducing a scheme for providing employees with access to the company’s shares through the allocation of free shares and/or stock options, etc. (see Chapter 41);
• defining the company strategy in a form that is simple and easy to communicate, which will become the equity story to be told to the market at the time of listing.

From the start of this phase, the company should seek the assistance of an investment bank, which will act as a link between the company and the market. The company will also have to retain the services of a law firm, an accounting firm and possibly a PR agency.

THE 10 LARGEST IPOS WORLDWIDE OF ALL TIME

Section 42.3 Execution of the IPO

Section 42.4 Underpricing of IPOs

If statistics are to be believed, the share price of a newly floated company generally rises by around 10% (UK) and 15–16% (USA or France) on the IPO price in the days following flotation (see Chapter 25). It would also appear that this discount at which shares are sold or issued at the time of an IPO is volatile over time, compared with a balanced value – high in the 1960s, lower in the 1970s to 1980s, and then high again in the 2000s. Following research, many different explanations for this discount have been put forward. The main ones are:

• This underpricing is theoretically due to the asymmetry of information between the seller and the investors or intermediaries. The former has more information on the company’s prospects, while the latter have a good idea of market demand. A deal is therefore possible, but price is paramount.
• In this asymmetrical situation, signal theory says that the sale of shares by the shareholders is a negative signal, so the seller has to “leave some money on the table” in return for ensuring that the IPO goes off smoothly and to investors’ satisfaction.
• Some explanations are more complex and are based on the degree of information that the various investors have on the true value of the company. Institutional investors will generally have better information and a more in-depth understanding of companies that are about to arrive on the market. Such “informed” investors will only be interested in good deals and will not be tempted by overvalued IPOs. Less well-informed investors, who will thus be involved in all financings, will find that they are better served in unattractive operations. They will not be as present on more attractive deals. If the average IPO were not underpriced, less well-informed investors would be excluded and would end up abandoning the market. In seeking to retain these investors, who provide valuable and necessary liquidity to the market, IPOs are carried out at a discount.
• There are some who argue (not very convincingly) that underpricing can limit the risk of legal disputes with investors who would feel as if they had been swindled because they’d made a bad investment.

Section 42.5 How to carry out a successful IPO

The fact that a number of IPOs are cancelled or postponed (Shellanoo in Israel, Mysis in the UK, United Petroleum in Australia) shows that this is a tricky process and that success is not always guaranteed.

A successful IPO is the combination of a number of factors:

• the intrinsic quality of the company: market share, growth and clarity of the activity, management experience, capital structure, should not be unusual, etc. These factors are assessed on the basis of comparable companies that are already listed, since the listing of the company is offering a new choice to investors within the same investment universe;
• a clear and convincing explanation of the sellers’ motivations, as the market will always fear that they are selling their shares because their best results have already been achieved. This is why a flotation through a share issue for financing investments is preferable to the sale of shares (signalling theory);
• agreement on the price, which is much easier to achieve when the stock markets are performing well, and very difficult to achieve when they are performing badly. This is the most frequent reason for cancelling an IPO.

From a tactical point of view, and when the stock markets are performing badly, marketing is crucial. Readers, who have been aware since Chapter 1 that a good financial director is first and foremost a good marketing manager, will not be surprised! Marketing involves:

• familiarising investors with the stock market candidate a few months before the roadshows themselves begin, through informal meetings (pilot fishing);
• entry into the company’s capital by investors seen as cornerstone or anchor investors a few weeks before the IPO when the regulations allow this, which will encourage other investors to follow suit. For example, Showroom privé.com sold a 3% stake in the Chinese group VIPShop three months before its IPO;
• tight management of communication over the envisaged price. For example, Glencore let it be known that it was considering a flotation of over $60bn and when a lower price was announced, this was perceived as good news. This is called behavioural finance! It is true that the difficulty of valuing this complex group made this manoeuvre much easier;
• a price seen as lower than the equilibrium value, enabling investors to hope for capital gains after a few months. For example, the cable group Altice fixed its IPO price in the middle of the indicative bracket. Two weeks after listing, the share price stabilised at 6% above the IPO price.

Sometimes the market is a buyers’ market, and these buyers do not hesitate to twist the arm of investors seeking liquidity. It’s just as well to be aware of this and not try to play another game if you want to list a company on the stock exchange.

The first days of listing are crucial, because starting a stock market career with a share price that is lower than the IPO price does not make a very good impression on investors. On the other hand, slightly undervaluing the share when it is listed means that the price will rise by a few percentage points during its first days of listing. This puts everybody in a good mood!

Finally, in the long term the company and its managers will have to learn to live with daily constraints on their behaviour imposed by the periodical distribution of financial information, by managing earnings so as not to disappoint investors and thereby risk lower levels of investment than an unlisted company might face, and because they will be taking fewer risks in general. Furthermore, all shareholders must be treated equally, and managers are going to have to get used to the value of the company being published every day; sometimes this value will be low even though results are good. This can have an impact on the morale of employees and on shareholders’ assets, and it could lead to a change of control in the event of major changes in the capital structure.

That’s just life on the stock exchange!

Section 42.6 Public to private

A company (or the shareholders) will first start considering a public-to-private move when the reasons why it decided to list its shares in the first place, for the most part, become irrelevant. It has to weigh the cost of listing – direct costs: stock exchange fees, publication of annual reports, meetings with analysts, employment of investor relations staff; and indirect costs: requirement to disclose more information to the public and to competitors, market influence on strategy, management’s time spent talking to the market, etc. – against the benefits of listing when deciding whether the company should remain listed or not. This is especially the case if:

• the company no longer needs large amounts of outside equity and shareholders themselves are able to meet any equity requirements it may have. The company no longer has any ambition to raise capital on the market or to pay for acquisitions in shares;
• the stock exchange no longer provides minority shareholders with sufficient liquidity (which is often rapidly the case for smaller companies which only really benefit from liquidity at the time of their IPO). Listing then becomes a theoretical issue and institutional investors lose interest in the share;
• the company no longer needs the stock exchange in order to increase awareness of its products or services.

The second type of reason why companies delist is financial. Large shareholders, whether majority shareholders or not, may consider that the share price does not reflect the intrinsic value of the company. Turning a problem into an opportunity, such shareholders could offer minority shareholders an exit, thus giving them a larger share of the creation of future value.

A public tender offer must be launched in order to delist a company. Delisting is possible if the majority shareholder exceeds a threshold, often 90% or 95%, as it is then obliged to acquire the rest of the shares. This is known as a squeeze-out. In practice, this amounts to forcing minority shareholders to sell any outstanding shares. Because this is a form of property expropriation, the price of the operation is analysed very closely by the market regulator. In most countries, a fairness opinion has to be drawn up by an independent, qualified financial expert.

But let’s not delude ourselves – no matter how the company’s share has performed, minority shareholders will insist that the price they’re offered reflects the intrinsic value of their shares. If it doesn’t, they won’t tender their shares in the offer. Accordingly, it is not surprising to note that, even though there is no change in control, tender offers launched for the purpose of delisting a company are made at a premium that is equivalent to the premium paid for takeovers.

If investors are below the squeeze-out threshold, they first have to launch an offer on the company’s shares, hoping to go above the squeeze-out threshold so as to be able to take the company private. This is a P-to-P, public-to-private, deal.

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